Question

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (since leasing is a common practice for expensive, specialised, high-tech equipment). The scanner costs $6.3 million, and it qualifies for a 30% capital cost allowance (CCA) annual rate. Due to radiation contamination, it is valueless at the end of four years. You can lease it for $1.875 million per year over four years - with annual lease payments being made at end of each year.

a) Assume the tax rate is 37%. You can borrow at 8.0% pre-tax. Should you lease or buy?

Hint: Calculate the present value of CCA annual tax shields (PVCCATS), follow by calculating the net advantage to leasing (NAL). Refer slides 12-17 (Week 8 - Chapter 22 on Leasing).

b) What are the cash flows from the lease - from the lessor's point of view? Assume same 37% tax bracket.

c) What would the annual lease payment have to be in order for both lessor and lessee to be indifferent (ie. no gain nor loss) to the lease? Hint: Look into the NAL formula.

d) Assuming your company does not need to pay corporate taxes for the next 4 years, what is the present value (NAL) of the cash flows from leasing?